| Stock
Market Unrelenting Bullishness Amidst Deteriorating Economic
Conditions
NOV
07 2008
By Mike "Mish" Shedlock
World-wide, stock valuations have fallen to a level roughly
equivalent to the one that prevailed during the 1970s, according
to Citigroup. As of Thursday, global stocks were trading
at roughly 10.3 times their earnings for the previous 12
months, even lower than the average of 11.4 through the
1970s.
The selloff has
been especially savage in emerging markets. Earlier this
week, investors drove down stocks in such markets to valuations
that were almost as low as those during the nadir of the
Asian crisis in the late 1990s, according to a Merrill Lynch
report.
"There are
a host of things that have sold off to extraordinarily ridiculous
levels," says Uri Landesman, a senior portfolio manager
at ING Investment Management in New York. "The baby
and all its diapers and onesies were thrown out with the
bathwater."
Indian shares,
which last September traded at about 25 times the previous
12 months' earnings, now trade at just over 10 times, using
Citigroup and MSCI figures. Shares of Chinese companies
open to foreign investors are down to about nine times,
from 27 times. And Russian shares are trading at about 4.4
times prior earnings, from 13 times.
"Everything
looks cheap," says Ronald Frashure, co-chief investment
officer of Acadian Asset Management in Boston. That is,
"unless the world is going into something like the
Great Depression, and we think there's a low probability
of that occurring."
Historically
Cheap Amid Volatility
MSNBC
is reporting Stocks seen as historically cheap amid volatility.
Analysts and
money managers agree that unusually sharp volatility and
a freeze in credit markets have made it more difficult than
ever to forecast a market bottom.
But many of them
also say it's clear that stocks are a bargain at current
prices, and poised to climb over the long run, even if they
zigzag short-term. If third-quarter earnings end up coming
in below Wall Street's expectations, some analysts still
see room for stocks to gain.
"Any way
you slice it, stocks will be either extremely cheap, or
cheap, or just average," said Art Hogan, chief market
strategist at Jefferies & Co.
The high
price of panic
MarketWatch
warns about The high price of panic.
If you didn't
see the market's meltdown coming, you have plenty of company.
If you're selling now, it's probably too late. For a longer-term,
retirement-focused shareholder -- and that's most of us
-- selling stocks just because they could fall further not
only locks in losses, but also makes it less likely that
you'll participate in powerful market rallies. Missing those
days can be hazardous to your wealth.
Hazardous
To Your Wealth
It is stunning
how ass backwards MarketWatch has things. Participating
in those rallies is what is hazardous for your health because
the biggest rallies are in bear markets. There were two
10% rallies in October yet the month finished down 15%.
Any long term investor who caught both of them lost money.
A Sunnier Season
The
cover story of Barron's is called A Sunnier Season.
IT MUST REALLY
TAKE A LOT TO SCARE AMERICA'S money managers. The Dow Jones
Industrial Average is down by 30%. Credit is near-impossible
to get. A global recession looms, and the cost to clean
up Wall Street's mess is climbing into the trillions. And
yet, against these odds, 50% of the investment pros responding
to our latest Big Money poll say they're bullish or very
bullish about the stock market's prospects through the middle
of next year.
Barron's latest
Big Money poll reveals unrelenting bullishness among many
money managers, despite their pronostications for a "contagious"
recession and punk profits through 2009.
NOW THAT STOCKS
HAVE tumbled to five-year lows, 62% of Big Money respondents
say they're undervalued, up from 55% last spring. A scant
7% think equities are overvalued at today's levels. Almost
70% say stocks will be the best-performing asset class in
2009, compared with 13% who favor cash, and 11% who prefer
bonds.
"A lot of
money is on the sidelines," says David C. Hartzell,
founder of Cornell Capital Management in Buffalo, N.Y.,
which handles about $50 million. "But if you're a money
manager, you can't afford to be out of the market, because
you might miss the comeback."
Sideline
Cash Nonsense
There's that
sideline cash nonsense again. Sideline cash does not come
into the market except at IPO time. Otherwise there is a
seller for every buyer. If someone buys $50 million of Microsoft
with "sideline cash" someone else will have $50
million in "sideline cash" to buy stocks with.
I remain amazed at the number of people who manage money
that do not know how the stock market even works.
Reasonably
Undervalued
In Risk
Management and Hooke's Law Hussman makes a case for
gradually building an investment exposure.
Though I continue
to view stocks as reasonably undervalued, I'm a bit concerned
that so many investors appear to be looking for a bottom.
The S&P 500 currently reflects the best valuations since
the 1990 bear market low. We aren't trying to catch a rally
– we are gradually building an investment exposure
based on valuations.
My view is that
the market is undervalued, that it is priced to deliver
attractive long-term returns, and that there is an increasing
likelihood of a major bear market advance – but I
don't believe that any of this puts a “floor”
below the market in the very short term, and I don't believe
markets are apt to bottom while everyone is still looking
for a bottom.
As an economist,
it's clear that the parallels to 1929 are terribly overblown,
not least because unlike the Great Depression, governments
in this instance have opened a floodgate of liquidity, capital
and base money – which they failed to do back then.
Even if we were to completely zero out two solid years of
earnings for the S&P 500, the fact is that more than
90% of the value of U.S. stocks would reside in the cash
flows beyond that point. The main issue for good, established
companies here is not the risk to the long-term stream of
cash flows, but to what extent the uncertainty about the
coming year or two of earnings will frighten investors to
sell at depressed prices (thereby pricing stocks to deliver
even higher long-term returns).
Of the above
articles, only Hussman presented a thorough case worth discussing.
That said, I disagree with his thesis. Should the S&P
drop to 600 (and I think it will) that is approximately
a 40% drop from here. Such a drop is worth avoiding no matter
how many 10% rallies there are along the way.
I laid my thesis
for the S&P falling to 600 or lower in S&P
500 Crash Count Compared To Nikkei Index. Here is the
pertinent snip about fundamentals, see the article for the
technicals.
S&P
500 Fundamentals
* The period
from 2003 to 2008 was the biggest credit bubble in history,
not just in the US but worldwide. It is unrealistic to
expect the bust to be anything other than the biggest
credit bust in history.
* Unemployment is 6.1% and rising. My unemployment target
is 8% for 2009 and continuing higher into 2010.Think what
rising unemployment will do to foreclosures, defaults
on credit cards, bankruptcies, commercial real estate,
and corporate earnings.
* Banks and brokerages made immense profits being leveraged
30-1 to 50-1. However, brokerages are now under control
of the Fed. Leverage is still unwinding and will be lowered
to 10-1 or possibly lower. Reduced leveraged means less
risk, but also reduced lower profit opportunity.
* Boomers are heading into retirement, and a portion of
their retirement plan (rising home prices) has been wiped
out. Another portion of boomer retirement plans are being
wiped out in the stock market crash.
* As a result of the above, those boomers will be doing
less spending and more savings. Don't expect retail sales
or store profits to come soaring back anytime soon.
* Peak
Credit has been reached and a secular shift to frugality
and risk aversion has begun.
* Stock markets returning from extreme conditions do not
just drop to the trendline, they overshoot it.
* Children who have seen their parents wiped out in bankruptcy
or foreclosed on are going to have a completely different
attitude towards debt than their reckless parents did.
Expect to see more frugality from parents and their children
alike.
It is impossible
to predict the future of course, but fundamentally as well
as technically there is every reason to believe lower lows
are coming, and the rebound off those lows will be anemic
compared to past recoveries. Those looking for an L shaped
recession are likely looking the right direction.
With so much
"Unrelenting Bullishness" in the face of deteriorating
economic conditions and a global economy that is clearly
in recession, I simply do not see the earnings projections
for 2009 holding up. Nor do I see bullish market psychology
coming back.
And while there
may not be another great depression, the similarities between
2008 and 1929 are massive. Inquiring minds may wish to review
a
Crash Course For Bernanke for a comparison.
A massive secular
shift in time preference away from risk is now underway.
That pendulum has a long way to go before it hits an opposite
extreme in the other direction. In my view, bulls are missing
the implications of this secular shift.
By Mike "Mish"
Shedlock
http://globaleconomicanalysis.blogspot.com
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